The income investments available to the individual investor via the U.S. stock markets and that are covered by QuantumOnline.com include exchange-traded fixed income investments, common stocks for income, and the semi-related Wall Street special products that are described below. Note that these income security descriptions are still under development and if you have any suggestions concerning them, please email us using our Feedback form.
There are six basic types of exchange-traded fixed income investments readily available to the individual investor. The six types are preferred stocks, trust preferred securities, third party trust preferreds, exchange-traded debt securities, convertible preferreds, and mandatory convertible securities. Each of these six types of securities have their own individual table and list on the QuantumOnline.com website which will allow the QOL user to research the individual securities included under the particular security type.
Note the terms "exchange-traded" and "fixed income". The term "exchange-traded" means that the securities are traded on the U.S. stock exchanges and are easily purchased by an individual investor in any quantity and at reasonable brokerage commissions via either discount or full service brokers. The term "fixed income" means that the dividend or interest payment terms are fixed at specific values at the initial public offering (IPO) via the IPO prospectus issued at the time of the original sale of the securities to the public. Exchange-traded fixed income securities generally offer the maximum current investment income that is available to the individual investor via the stock markets. The distributions paid by these securities are stable and are fixed by the provisions of the IPO prospectus and will remain fixed over the years. The market prices of these securities are relatively stable and are affected mainly by changes in interest rates and by deteriorating company financial condition. Credit ratings on any of the security types range from investment grade to unrated to securities in or near bankruptcy and must be evaluated on an individual security basis.
Preferred Stocks - Preferred stocks are the traditional preferred stock of corporate finance. They were the only type of preferred stock issued up until the early 1990s when trust preferreds appeared on the scene. Now traditional preferred stocks are issued mainly by REITS, some banks, closed-end funds, etc. Traditional preferred stocks generally are perpetual securities that have no stated maturity date. Recently issued preferreds are redeemable on or after five years from the date of issue at the issuer's option at par (the issue price) while the older preferreds are now redeemable any time at the issuer's option, normally at a small premium. Most preferred stocks pay quarterly dividends while a few pay monthly dividends. In payment of dividends and upon liquidation, the traditional preferred ranks junior to the company's debt and senior to the company's common stock. Most traditional preferreds are eligible for the 15% tax rate with the exception of the preferreds issued by REITs which are NOT eligible for the lower tax rate.
The general attributes of preferred stocks are:
Trust Preferred Securities - Trust preferreds represent most of the new preferred security offerings being issued recently. The trust preferred is a hybrid security consisting of a preferred stock issued by a special trust and a debt security issued by the company. The special trust is a subsidiary of the company set up solely for the purpose of selling and administering the trust preferred securities. The trust sells their preferred securities to investors and then uses the proceeds from the sale of the trust preferred securities to buy debt securities (debentures, etc.) from the company setting up the trust. The debt securities are generally junior subordinated deferrable interest debentures, which are the lowest ranked of the debt securities issued by the company, and which generally have a maturity date of 30 to 50 years from the date of issue. The interest payments of the debt securities, paid by the company to the trust, are used to fund the trust's distributions to the preferred security holders. When the debt securities mature and are paid off, the trust in turn uses those funds to pay off the trust preferred securities which mature on the same date as the debt securities. Trust preferreds can be redeemed (called) at the company's option, generally at the issue price (liquidation preference), and generally on or after five years from the date of issue. Redemption of the securities, on or after the specified optional redemption date, is optional for the company but, if called, the call for redemption is mandatory for the holder of the securities. The debt securities generally have a deferrable interest clause that allows the company to defer distributions for up to five years at their option and for any reason but not beyond the maturity date. A distribution deferral will generate a very unpleasant situation for the preferred holder as the tax laws require the holder to pay taxes on the deferred but accruing dividends even though the holders is not receiving any cash. The company also provides a rather limited guarantee for the trust preferred that guarantees that, if the company pays the interest payment to the trust, the company guarantees that the trust will pay the dividend payments to the security holders. The advantage of this hybrid arrangement to the company is that the interest paid on the debt securities is deductible from their income taxes while normal preferred dividends would not be deductible. Trust preferreds are NOT eligible for the 15% tax rate on dividends.
The general attributes of trust preferred stocks are:
Third Party Trust Preferred Securities - Third party trust preferreds (TPTPs) are securities generated by Wall Street firms such as Merrill Lynch (Merrill Lynch Depositor), Lehman Brothers (Lehman ABS), Morgan Stanley (MS Structured Products) and Citigroup Global Markets, formerly Salomon Smith Barney (Structured Products Corp.) and others. The securities are sold under a variety of names and acronyms including CABCO Trusts, Corporate Backed Trust Certificates (CBTCs), CorTS, PCARS, PPLUS, SATURNS, STEERS, TRUCs, etc. The firms buy institutional preferred and debt securities on the open market and then repackage them for sale to individual investors. To do this, the firm sets up a trust that buys the institutional securities from the firm and then sells the third party trust preferred securities to investors. Then, the trust collects the distributions from the underlying security issuer and pays the investors their dividends as established in the trust security's IPO prospectus. The distribution percentage paid to investors normally differs from the underlying security's distribution as the firm has generally bought the underlying securities at a premium or discount from the original issue price. Another basic difference of these securities is that they generally pay their distributions semi-annually rather than quarterly. These securities often have some unusual call provisions involving call warrants, etc. that are quite difficult to understand but often boil down to the securities in reality being callable on or after five years from the date of issue at par. Third party trust preferreds are NOT eligible for the 15% tax rate as the underlying security issuer uses the interest paid as a tax deductible expense which makes the security ineligible for the new tax rate.
The general attributes of third party trust preferred securities are:
Exchange-Traded Debt Securities - Exchange-traded debt securities (ETDSs) are corporate debt securities designed for sale to the individual investor. They include the debentures, notes and bonds that are traded on the stock exchanges and resemble preferred stocks in their basic features. Exchange-traded debt securities generally mature in 30 to 100 years. The debt securities are normally redeemable at the issuer's option on or after five years from the date of issue at par. Most of these debt securities pay quarterly interest distributions. In payment of interest and upon liquidation, the exchange-traded debt securities rank junior to the company's secured debt and senior to the company's preferred and common stock. In contrast to the more common $1000 corporate bonds, exchange-traded debt securities are issued in $25 denominations and can be traded on the stock exchanges in the same manner as common stocks. These debt securities are NOT eligible for the 15% tax rate on dividends as they pay interest, not dividends.
The general attributes of exchange-traded debt securities are:
Convertible Preferreds - Convertible preferreds have a $10, $25, $50, or $100 liquidation preference (issue price), and pay a fixed quarterly dividend. The shares are convertible any time at the holder's option into a specified number of common shares based on a specified conversion price for the common shares. Generally the company has the right to force conversion of the preferred shares whenever the price of the common stock equals or exceeds a specified price for a specified period such as 20 trading days. They are sometimes redeemable (callable) at the issuer's option on or after two to five years from the date of issue at a specified call price under a variety of circumstances. In regards to the payment of dividends and upon liquidation, these preferred shares normally rank junior to the company's debt, equally with other traditional preferreds of the company and senior to the common shares of the company. These convertibles offer the possibility of market price appreciation (or depreciation) if the price of the company's common increases and therefore can provide some inflation protection to the income investor together with the associated market risk. These convertibles would generally pay a slightly lower dividend rate than preferred stocks. The conversion provisions can be complicated and each individual convertible should be studied via the QuantumOnline description and the prospectus and the special conversion terms understood before considering a purchase. The dividends paid by at least most of the convertible preferreds are eligible for the 15% tax rate.
The general attributes of convertible preferred stocks are:
Mandatory Convertible Securities - Mandatory convertible securities are similar to convertible preferreds with the very major exception that they have a fixed conversion date and a variable conversion rate in terms of the number of common shares per preferred share. They include Equity Units, Equity Security Units, ACES, DECS, FELINE PACS, FELINE PRIDES, MEDS, PCARS, PEPS, PIES, PRIDES, SAILS, etc. Mandatory convertible securities have many special provisions that need to be understood by the investor before any purchase is considered. In general, the securities pay higher distribution rates than preferred stocks. The securities are generally comprised of a stock purchase warrant and a debt security. They are mandatorily convertible at a specific date (generally 3 years from the date of issue) into a variable number of shares of the common stock of the company with the number of shares depending on the market price at the time specified for mandatory conversion. The potential investor in these complicated securities should definitely read and understand the terms of these securities as summarized in the QuantumOnline security description and as defined in the issue's IPO prospectus before considering a purchase. Since the mandatory convertible securities pay distributions based on a debt security that pays interest, the distributions of these securities are not eligible for the 15% tax rate.
The general attributes of mandatory convertible securities are:
Real Estate Investment Trusts (REITs) -
A real estate investment trust (REIT) is a company dedicated to owning and, in most cases, operating income-producing real estate, such as apartments, shopping centers, offices and warehouses. Some REITs also are engaged in financing real estate. Most importantly, to qualify as a REIT a company is legally required to pay virtually all of its taxable income (90 percent) to its shareholders every year. A REIT may deduct the dividends paid to the shareholders from its corporate tax bill so long as the company's assets are primarily composed of real estate held for the long term, the company's income is mainly derived from real estate, and the company pays out at least 90 percent of its taxable income to shareholders. The main benefit of being a REIT is one level of taxation. The main limitation of being a REIT is a restriction on earnings retained by the company. For a REIT to grow, capital must come from money raised in the investment marketplace as well as money generated internally. For further information on REITs, see the website of the National Association of Real Estate Investment Trusts (NAREIT). Dividends paid by REITS do NOT qualify for the 15% tax rate on dividends.
Corresponding QuantumOnline List - Real Estate Investment Trusts (REIT) List.
Master Limited Partnerships -
Most Master Limited Partnerships (MLPs) operate in oil & gas related businesses including energy processing and distribution. The remaining MPLs operate in a variety of businesses including coal, timber, other minerals, real estate, and some miscellaneous businesses. Master Limited Partnerships (MLP) are pass-through entities or businesses that are taxed at the unitholder level and generally are not subject to federal or state income tax at the partnership level. Annual income, gains, losses, deductions or credits of the MLP pass through directly to its unitholders. Unitholders report their allocated shares of these amounts on their individual tax returns, as though the unitholder had incurred these items directly. When the tax reporting season arrives, the MLP will furnish investors with a schedule K-1 to provide the information required for income tax reporting purposes. For a comprehensive discussion of what MLPs are and how they work, see the National Association of Publicly Traded Partnerships' (formerly the Coalition of Publicly Traded Partnerships) website. MLPs do not pay income taxes on their earnings and therefore their "dividends" are not eligible for the 15% tax rate.
Corresponding QuantumOnline List - Master Limited Partnerships List.
U.S. Royalty Trusts -
U.S. Royalty trusts are established to receive the royalties or net profit interests in a specific group of assets and to pay out those funds to their unitholders. The assets and the net profit interests in those assets are specified when the trust is originally established. Most of the U.S. royalty trusts provide dividend payments which are based on the oil and gas production of specified properties. The trust assets are limited to the net profits interests in their specific assets which have a limited economic life. Trust unitholders are taxed directly on their proportional share of the trust income. U.S. Royalty trusts distribute substantially all trust income to unit holders. Royalty trusts pay monthly or quarterly income that varies over time as the production of the underlying assets varies and generally gradually declines. Payments to unitholders will also vary with the market price of oil and natural gas. U.S. Royalty trusts are considered as grantor trusts for income tax purposes and the unit holders are taxed directly for their share of the trust income and entitled to their share of trust deductions. In the case of oil and gas royalty trusts, unitholders are entitled to tax depletion deductions and tax credits. The trusts provide unitholders with the quarterly and annual reports required so that the unitholder can properly report their share of the income and deductions of the trust for income tax purposes. The distributions of U.S. royalty trusts are not eligible for the 15% tax rate as the trust does not pay income taxes on their profits.
Corresponding QuantumOnline Lists - U.S. Royalty Trusts List.
Canadian Royalty Trusts -
Canadian Royalty trusts are a different animal than U.S. Royalty Trusts. First, they renew their holdings and operate more like an oil and gas company than does a U.S. Royalty Trust. Generally the Canadian trusts do not do exploratory drilling. When they do drilling it would generally be to increase production of their existing fields and holdings. Most of the Canadian royalty trusts provide dividend payments which are based on the oil and gas production. Royalty trusts pay monthly or quarterly income that varies over time as the production of their underlying assets varies. Payments to unitholders will also vary with the market price of oil and natural gas. As Canadian Royalty Trusts replenish their reserves (versus U.S royalty trusts that do not replenish their reserves), the distributions of Canadian royalty trusts are generally considered to be eligible for the 15% tax rate. We have not found any official confirmation of the eligibility of Canadian Royalty Trusts for the 15% tax rate and the potential investor should confirm this eligibility from other sources.
On February 25, 2005 the Government of Canada passed Bill C-33. Under the terms of Bill C-33, commencing January 1, 2005 a non-refundable withholding tax of 15% will be applied to the entire distribution paid to U.S. residents by "Canadian Royalty Trusts", including both the taxable and return of capital portions of the distributions. Similarly, non-residents of countries with whom there is no reciprocal tax treaty with Canada will be subject to a non-refundable withholding tax of 25% on the entire distribution paid. These withholding taxes will be applied uniformly to units held in both taxable and home jurisdiction tax-exempt accounts. Non-resident unit holders are strongly advised to consult a resident tax advisor to determine the deductibility of these taxes in their resident jurisdiction. This Canadian law means that tax exempt accounts such as IRA's will be subject to the 15% withholding and that the recovery of the Canadian withholding amounts will be probably difficult or impossible to achieve making Canadian Royalty Trusts a questionable choice for tax exempt accounts such as IRAs. Taxable accounts should be able to claim the 15% Canadian withholding as a credit on their U.S. income tax return and therefore easily recover the withholding amount.
Corresponding QuantumOnline Lists - Canadian Royalty Trusts List.
Business Development Companies -
Business development company (BDC) regulation was created in 1980 by Congress to encourage the flow of public equity capital to private businesses in the United States. BDCs, like all mutual funds and closed-end funds, are regulated by the Investment Company Act of 1940. However, BDCs are unique because they focus on investing in private companies, rather than publicly traded companies. BDCs report to shareholders like traditional operating companies and file regular quarterly and annual reports with the Securities and Exchange Commission. BDCs are required to make available significant managerial assistance to their portfolio companies. By investing in a BDC, shareholders enjoy the liquidity of a publicly traded stock, while participating in the private equity industry. Private company investing has traditionally only been available to "accredited investors" - generally, large institutional investment funds and other sophisticated professional investors. Apart from the opportunity that BDCs offer to the general investing public, individual investors have few other opportunities to invest in private companies, particularly on a "pooled" basis, which diversifies the risk of any one investment across the whole portfolio.
Corresponding QuantumOnline List - Business Development Companies List.
Closed-End Funds -
The vast majority of closed-end funds (CEFs) or closed-end funds are income orientated and pay either taxable or tax-exempt income. Closed-end funds offer the income investor an alternative to direct investments in corporate or municipal bonds, REITS, preferreds, etc. Closed-end funds have a fixed number of shares outstanding. Following an initial public offering, their shares are traded on a stock exchange in the same manner as common stocks and they may be purchased and sold through discount or full-service brokers. Transactions in shares of closed-end funds are based on their market price as determined by the forces of supply and demand on the stock markets. The price of a CEF may be above (at a premium to) or below (at a discount to) it's Net Asset Value (NAV). The transaction price will also include a customary brokerage charge. The invested capital in a closed-end fund is fixed and will change only at the direction of management. Capital can be increased through the issuance of shares in conjunction with a rights offering or through the reinvestment of certain dividend payments. Capital can be reduced when shares of the fund are repurchased in conjunction with a stock repurchase program or tender offer. For further information on closed-end funds, go to the website of the The Closed-End Fund Association. Dividends received by the closed-end funds that are eligible for the 15% tax rate on dividends will be passed-through by the funds to their shareholders. Therefore a portion of the dividends paid by taxable income closed-end funds will be eligible for the 15% tax rate. The portion will vary from fund to fund and investors will have to consult each individual fund for information.
Corresponding QuantumOnline List - Closed-End Funds List.
Exchange-Traded Funds (Index ETFs) -
Exchange-Traded Funds (Index ETFs) are index funds or trusts that are based on a particular stock market index (i.e. the Dow Jones Industrial Average, the S&P 500 Index, etc.). The Index ETF seeks investment results that correspond to the price and yield performance of the target index, before fees and expenses. Essentially, an individual Index ETF attempts to achieve similar results to corresponding index by purchasing all (or a representative sample) of the securities included in the reference index and in percentages identical to (or similar to) the percentages reflected in the associated index. With Index ETF's, investors can buy or sell shares in the collective performance of an entire diversified stock or bond portfolio as a single security. Index ETFs are available with index portfolios reflecting the broad stock markets, stock industry sectors, international stocks, and U.S. Treasury and corporate bond indexes providing a wide array of investment possibilities. Index ETFs have very low management fees, no 12b-1 fees for commisions to selling brokers, and minimal capital gains distributions to effect your year-end taxes since the funds rarely trades their securities. Since the fund manager creates new shares when demand justifies their issuance, the market price of Index ETFs remains very close to the fund's net asset value.
Corresponding QuantumOnline List - Exchange-Traded Funds (Index ETFs) List.
Special Products based on Market Indexes -
These special securities are senior unsecured medium term notes of the issuers. Examples of these special notes include BOXES, BRIDGES, BULS, MITTS, MPS, SUNS, TIERS and a variety of market participation notes. Most of these notes make no payments prior to maturity and are generally not callable prior to maturity. At maturity, the securities offer maturity payments which are based on the results of a stock market index such as the S&P 500, the Dow Jones Industrial Average, etc. over the term of the note. The maturity payment can be based on the final return of the index or the average return of the Index at specified valuation dates over the term of the notes. The maturity payments are often subject to a appreciation cap or a participation rate. The securities often guarantee that the holder will get back at least the amount of the original investment. Other securities will have maturity payments with capped upside returns but no cap on potential declines in the value of the Index. The notes generally receive investment grade credit ratings based on the credit rating of the issuer. These excellent credit ratings indicate only that you are very likely to get the maturity payment when due but not how much that maturity payment will be. The potential purchaser needs to study and understand the effects of the maturity payment valuation methods (average or final values), the effect of appreciation caps (maximum appreciation per month or quarter), participation rates (i.e. 70% of the increase in the value of the Index) and other aspects of the securities. Each security needs to be carefully studied to be understood as seemingly minor differences in the terms of the securities could have major effects on the final maturity payment. These are securities for sophisticated investors who do their homework. Any investment in these securities should definitely be preceded by the investor reading our description of the security and also studying and understanding the IPO prospectus.
Corresponding QuantumOnline List - Special Investment Products based on Indexes List.
Special Products based on Company Stocks -
These special securities are senior unsecured medium term notes of the issuers. Examples of these special notes include include BRIDGES, PRUDENTS, TARGETS and others. These notes make no payments prior to maturity and are generally not callable prior to maturity. At maturity, the securities offer maturity payments which are based on the results of a basket of companies or on the common stock of an individual company over the term of the note. The maturity payment can be based on the average return of the basket at specified valuation dates over the term of the notes and sometimes on the final return of a company stock. The maturity payments are often subject to appreciation caps. The securities often guarantee that the holder will get back at least the amount of the original investment. Some securities will have maturity payments subject to capped upside returns but with no cap on potential declines in the value of the basket or company stock. The notes generally receive investment grade credit ratings based on the credit rating of the issuer. These excellent credit ratings indicate only that you are very likely to get the maturity payment when due but not how much that maturity payment will be. The potential purchaser needs to study and understand the effects of the maturity payment valuation methods (average or final values), the effect of appreciation caps (maximum appreciation per month or quarter), participation rates and other aspects of the securities. Each security needs to be carefully studied to be understood as seemingly minor differences in the terms of the securities could have major effects on the final maturity payment. These are securities for sophisticated investors who do their homework. Any investment in these securities should definitely be preceded by the investor reading our description of the security and also studying and understanding the security's terms as defined in the IPO prospectus.
Corresponding QuantumOnline List - Special Investment Products based on Companies List.
Special Products with a Stock Purchase -
These special securities are senior unsecured debt securities of the issuers. At maturity, the securities will deliver a specified number of shares of the related common stock to the holder generally only when the price of the associated stock has declined over the term of the security. Alternately, when the price of the common stock has increased, the securities will return the amount of the invested principal in cash. The securities generally pay quarterly distributions of 6% to 12% per annum. These securities mature in one to two years from the date of issue. Many of the securities are callable at the issuer's option at mid term and beyond. If called, the securities return a yield to call including all payments that can range from 15% to 30% per year or more. Acronyms and names for these special notes include include ELKS, SEQUINS, STRIDES, SPARQS, reverse exchangeable securities and others. The notes generally receive investment grade credit ratings based on the credit rating of the issuer. These excellent credit ratings indicate only that you are very likely to get the maturity payment when due but not how much that maturity payment will be. The potential purchaser needs to study and understand the effects of potential calls and the maturity payment provisions. These are securities for sophisticated investors who do their homework. Any investment in these securities should definitely be preceded by the investor reading our description of the security and also studying and understanding the security's terms as defined in the IPO prospectus.
Corresponding QuantumOnline List - Special Investment Products resulting in Common Stock Ownership List.